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What Every Business Should Know About Pricing

For many small businesses, survival depends increasingly on finding the ever-elusive “right price” for whatever goods or services are being sold. But there’s no magic formula.  No matter what you’re selling, the “right” price to ask is never clearly defined.

For one thing, costs differ from business to business. Online businesses, for example, don’t have the overhead of staffing retail stores and often aren’t subject to the same sales taxes. So an online store can sell at a lower price and still make a profit.

Chip Averwater, a third-generation retailer and chairman of Amro Music Stores in Memphis, TN, has seen it all and has developed a list of tried-and-true pricing advice for other business owners. Here are Averwater’s top pricing tips:

The right price isn’t a multiple of wholesale. It’s tempting to price by simply using a fixed-percentage markup from wholesale. But that strategy assumes all expenses of a sale are determined by the wholesale cost. To price correctly, argues Averwater, you must do it individually and by feel, with consideration given to the total expenses of the sale, customer price sensitivity, competitive options, and the sale’s potential contribution to other business.

Know the difference between wholesale cost and cost of the sale. Wholesale is the cost of the merchandise, not the cost of the sale. Think about it: The price paid to the manufacturer is only the first of many expenses in a transaction. Sales can’t be made without including expenses for rent, salaries, advertising, utilities, freight, maintenance, taxes and others. Just because a sale has a gross margin doesn’t mean it’s profitable.  Unless the price covers all of the sale’s expenses, you are taking money out of your own pocket to make it.

All sales should bear operating expenses. Some business owners subscribe to the theory that since expenses are fixed, so they should accept every sale that has a positive gross margin. But here’s the problem: When are expenses ever really fixed? Sales don’t happen in a vacuum. Boosting sales requires increases in personnel, space, inventory, handling, and virtually every other business expense. In fact, every sale incurs operating expenses so its price should be sufficient to cover them plus a profit.

Practice your pricing math daily. Turns out your math teachers were right. You do need this skill to survive in the real world. You need a clear idea of the cost of every sale, service, and activity your business engages in. That information helps you decide what to stock, what to promote, where to channel your investments and efforts, and of course, set prices. Averwater’s advice is to regularly sit down with a spreadsheet and divide the list of expenses across your product sales and services. Only then will your costs become clear.

Don’t try to offer the lowest price. You’ve probably seen it before: Weaker competitors offer lower prices to attract more customers. At first glance, this might not seem like a bad strategy. But those companies are crossing their fingers and hoping that when the dust settles, there will be a little profit left over.

“It’s futile to try to price below desperate competitors because they’ll always drop their prices below yours,” says Averwater. “Differentiation is almost always a better strategy. Offer superior products and services that customers are willing to pay more for.”

Reputations are made on price-sensitive items, margins on the rest. Price-sensitive items are the ones bought frequently and advertised often. In a grocery store, they’d include bread, milk, and soft drinks. In a musical instrument store, they’d be strings, reeds and picks. Because customers buy them often, price differences between stores are more apparent.

“Pricing these items low creates a value image for the store,” says Averwater. “Higher margins on other merchandise allow the store to make a profit.”

It won’t sell if it’s not on sale. Americans love the thrill of a bargain. In fact, customers have become so accustomed to discounts that many won’t make a significant purchase unless the product is on sale. Many furniture and clothing stores schedule only brief intervals between sales, which they use to catch up, restock, organize and collect prospects for the next sale. Many department stores end one sale only as the next begins.

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How to Counter the New Culture of Free

Free is a powerful force in the marketplace; especially online.  A fast-growing, Internet-inflamed “Culture of Free” is leaving more and more businesses in all industries and areas reeling in profit pain.  Companies large and small are seeking answers to a question that once seemed odd:  What can you do when your products or services are more popular than ever, but consumers don’t want to pay for them anymore?

Surprisingly, perhaps, there are some good answers.  Saul Berman, a partner in IBM Global Business Services who wrote the insightful new release Not for Free: Revenue Strategies for a New World (Harvard Business Review Press, Feb 17, 2011), argues that companies in nearly every industry are vulnerable to five profit-piercing threats that have facilitated the culture of free:

1)      High customer expectations for personalization, control, relevance and timeliness

2)      Low cost, saturation-level communications

3)      Bountiful, low-cost band width

4)      Plentiful, real-time data processing power

5)      Rapid-fire technology and competitive innovation

These trends and expectations affect even small local businesses.  Customers now instantly communicate local buying experiences; they expect restaurants, dry cleaners, health clubs and others to offer personalized, relevant offers and experiences.  And they have unprecedented access to price comparison and other competitive information.

Businesses are being forced to squeeze out revenue in new ways as markets shift.  But the changing landscape, Berman argues, creates new opportunities to grow revenues “organically” without expensive advertising or marketing programs, by simply changing your approach.  The key is this:  It’s not about creating killer new products or latching onto the new technology du jour.  It’s about understanding customers and delivering value.

How?  Start at the beginning – with your customers.  But be careful.  Most business owners, entrepreneurs and companies in general still view customers through an outdated mass segmentation lens based on age, income, gender or geography.  Such segmentation is dead; done in by technology.  In its places there’s a new type of segmentation based on how buyers actually behave – how they use your products, services and information.  This in turn sets the table for building revenue in new ways:

1)      Pricing innovation: It’s not just “how much” but also “when.”  No product is free – ever – notes Berman.  Someone always pays for it. So the answer is not to price your product at zero, but to innovate around the amount of money charged, and the point (or points) in time when you require customers to pay.  Successful approaches include: subscription plans, variable pricing, by-parts pricing, bundling, and rental models.

Rent The Runway, launched in late ‘09 by two Harvard Business School students, is a great example of pricing innovation.  The founders (Jennifer Hyman and Jenny Fleiss, shown in photo) took a traditional “buy-only” product (designer dresses) and reinvented it via subscription and “rental model” pricing.  Rent The Runway is a membership site (think “subscription”) that rents designer dresses to members to wear at all of life’s special occasions for less than 10% of what it would cost to buy one.  Women can outfit themselves in a different, cutting-edge designer fashion for every event they attend throughout the year for less than what they would have paid to buy a single dress in the past.

2)      Payer innovation: Sometimes the customer who pays is not the consumer of the product. Berman calls this “let’s have a (third) party.”  Since nothing is free, and somebody always pays, the trick is to think of alternative “somebody’s” who might pick up the tab, or part of it.  A classic example is TV shows.  They’re free to you – the advertisers pay.  Sponsorships and while-labeling are two other examples.  “While labeling allows product companies to sell outside of their traditional market without having to drum up demand themselves.”

3)      “Package” Innovation:   Don’t take “package” too literally. It’s not about the wrapper; it’s about all the benefits and features of a given a product or service.  Today’s most innovative companies are expanding revenue opportunities by changing the form an existing product takes.  There are three basic ways to think about it:

a.       Breaking the product down into components

b.      Integrating different pieces of the value proposition

c.       Extending value in new ways

Understanding the underlying elements of pricing, payer and packaging can help you rethink and reformulate your revenue strategies, and find new ways to keep customers paying today and in the future. For the latest updates, bookmark BizBest, or subscribe to the BizBest news feed.

Copyright © 2000-2011 BizBest Media Corp.  All Rights Reserved. 

7 Profit-Boosting Pricing Secrets

Profit margins and pricing are often misunderstood.  Many entrepreneurs assume that price increases put them at an automatic competitive disadvantage. But pricing consultant Rafi Mohammed argues that small, strategically targeted price increases can actually give a company a competitive edge.  The key is to bridge the profit disconnect.  Business owners often view pricing as a mix of markups, margins and matching the competition – plus a modicum of “gut feeling.”

But such an approach has no relevance for the most important component of all:  What customers are actually willing to pay.  As a result, most businesses leave profits on the table daily, argues Mohammed. Better pricing can be the quickest path to bigger profits. “In many cases, prices can be changed on Sunday night and new profits will start rolling in on Monday morning,” says Mohammed. Here are seven tips for proper pricing:

  1. Avoid the markup mistake: The most common pricing pitfall is setting your price based merely on a set markup.  Such cost-plus plans often forego potential profits because they never account for what customers are willing to pay.
  2. Price for value: Take a lesson from street vendors who understand better than anyone the principle of value-based pricing. Umbrella prices go up the moment it starts raining. It has nothing to do with the cost of the goods, and everything to do with the value the customer places on the product.
  3. Avoid one-size-fits-all: Pricing is more personal than you might think.  Customers have different needs, preferences and expectations. Some prefer package pricing, while some like a la carte. Use pricing tactics that serve those different needs.
  4. Let customers choose how much to pay:  Most businesses can boost profits by offering “good, better and best” type choices for a wide range of products and services. Think about creating different versions of what you offer at different price points.
  5. Create a different offering for your most price-sensitive customers:  For any given product or service, some customers are willing to pay more than others. Offer a spectrum of prices based on customer actions.  For example, those who line up to be “first to own” (think Apple iPad) are willing to pay a premium price.  Those who drive an hour to shop at outlet malls aren’t. Each new pricing tactic you create has the potential to add another customer segment to your mix.
  6. Focus on profit, not margin: Many businesses equate “high margin” with pricing success.  Maybe so, but a high margin can also point to opportunities to serve more customers by using discount tactics as well. Profit is your goal, not margin.
  7. Don’t discount across-the-board: Discounting can be damaging if handled badly. Mohammed recommends this: “Hold steady on prices to maintain current purchases, and then implement pricing tactics — such as discounts, lower versions or financing – to keep and attract new price-sensitive customers.”
Copyright © 2000-2011 BizBest Media Corp.  All Rights Reserved.